[RFC] Generate USDC revenue through $RARE covered call lending

[contentropy]

Intro
Based on some preliminary research and discussion with individuals involved with the DAO, it has come to my attention that SuperRare’s treasury is quite strongly denominated in idle $RARE tokens - these could be used more productively to generate revenue for the treasury and subsequently used to diversify and fund new initiatives. I would like to present this brief RFC memo to guage interest prior to making a full proposal that would help to achieve this objective through employing on-chain covered call strategies.

Idea
The idea is to leverage a portion of SuperRare’s treasury through on-chain covered call lending. This approach involves lending out a smaller part of currently idle $RARE tokens. By doing so, SuperRare can generate significant upfront revenue in USDC. The earned USDC can be immediately utilized for community needs. And unlike a simple token sale, covered call lending enables the treasury to diversify its holdings into stable assets without an immediate market impact.

Benefits

• Idle $RARE tokens can be used to generate upfront USDC revenue
• Immediate revenue and liquidity for operational and developmental activities
• Diversification of the treasury into stables
• Tokens don’t need to be sold, thus there’s no immediate market impact

Example Scenario
The diagram below shows indicative upfront premiums (as of Jan. 17, 2024) that the SuperRare treasury could earn across various loan duration (Days to Expiry) and upside cap (Relative Strike Level) combinations

For instance, SuperRare treasury lends $100k worth of $RARE for 90 days at a 110% upside cap. In turn, SuperRare treasury gets approx. $6.25k USDC upfront.

If the $RARE price remains below 110% after 90 days, the originally loaned $RARE is returned. If it exceeds 110%, SuperRare treasury receives $110k USDC (and still keeps the initial $6.25k USDC upfront as well).

Conclusion
This proposal outlines how the SuperRare community can generate USDC stablecoin revenue by using idle $RARE treasury for covered call lending. This approach not only diversifies the treasury but also avoids market impacts that could arise from outright selling $RARE tokens.

Would love to hear feedback and comments from the DAO and community and would be happy to make put together a full proposal outlining each of the above points in detail and describing additional benefits.

[Brennan]

Hey @contentropy, thanks for sharing this idea. I am not very familiar with covered call lending, so will need to do some research. Do you have any thoughts on how this might be implemented / facilitated? For example, any protocols already available that I could read up on to learn more?

[contentropy]

Hi Brennan thanks for the reply!

I’m actually on the team of MYSO Finance (https://myso.finance/), a peer-to-peer (p2p) lending protocol built on the EVM - the protocol is 3x audit by top security teams like Trail of Bits and we currently have a TVL of ~$1.8m.

We specialize in a number of cool use-cases like Zero-Liquidation Loans and custom DeFi loans, but one that we’ve been exploring is exactly the above i.e., on-chain, trustless covered calls for protocols/DAOs looking to diversify and earn stablecoin revenue. Happy to share a more detailed proposal describing the protocol in a bit more detail and how we can support!

W.r.t covered calls, they are a common structured product in TradFi used for yield enhancement. It essentially involves selling a call option to a borrower to earn an upfront premium while also limiting upside.

Without going into too much detail on the optionality (which I can describe in more detail in a full proposal), the general premise is that SuperRare would ‘lend’ $RARE and accept stablecoins as collateral and earn upfront stablecoin premiums with an upside cap. SuperRare can set its own terms for the loan, specifically the upside cap and loan duration.

Based on this upside cap and duration, you can earn a nice upfront stablecoin premium. The matrix above shows different upside cap/duration combinations and associated upside premiums. For example, if the DAO would lend $100k worth of $RARE for 90 days and set a 110% upside cap, the DAO would earn $6.25k USDC upfront and keep it, no matter what happens at loan expiry.

Then at loan expiry, one of two outcomes could happen
i) Price of $RARE is below the 110% upside cap → the rational borrower would return the $RARE and reclaim their $110k stablecoin collateral
ii) Price of $RARE iabove the 110% upside cap → the rational borrower would not repay the loan and the $110k in USDC stablecoins would be unlocked for the DAO to claim.

In essence this is a cool, battle-tested yield enhancement strategy to diversify the treasury without having to directly sell tokens and also earn revenue upfront.

As opposed to traditional covered call deals and MM arrangements, all loan execution happens on-chain through MYSO smart contracts and is trustless and transparent without any counterparty risk!

[Brennan]

Thanks for the great breakdown. This is interesting, and I appreciate the importance of the on-chain, transparent nature of this arrangement which is quite different to an OTC deal, for example - which is a staple in many DAO’s tool belts for treasury management. I’ve passed a link to this RFC to the Foundation Director to get his thoughts on viability